For FirstMark’s Matt Turck “Investing in early stage hardware ventures is not for the faint of heart”

May 26, 2015
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Raising VC money has been a daunting challenge for hardware startups for years.  However, with 25+ billion connected devices expected to come online by 2020, VCs are starting to venture back into the world of hardware.

Matt Turck, Managing Director at FirstMark Capital, has long been an advocate of the potential of IoT, and sees the rapid growth phase we’re currently in as only the beginning of an exciting new phase in innovation. Ahead of his talk at this week’s Connected Conference, Turck shared with us his perspective on the rapid rise of the connected hardware landscape and how its growth is affecting VC.

What are some of the differences in investing in hardware vs software?

Investing in early stage hardware ventures is not for the faint of heart. So many things can go wrong. It often takes longer and requires more money to ship than expected. The fundamental difference with software is that you can’t iterate as much, and fix issues as quickly. The product is what it is, and once you’ve shipped, you have to wait until the next shipment to make improvements. Also, you have to work with retailers if you truly want to move units, and that impacts your margins significantly. But for those that successfully survive the early stages of the process, things can get really interesting. As you gain market visibility and user adoption, you find yourself in a situation where you can get better terms on just about anything: contract manufacturer, components, retail. Your margins can improve dramatically. And consumers are willing to pay for hardware — you don’t have to fight a perception that your product should be free, as is the case for so many Internet/software consumer products. Successful hardware businesses can end up being remarkably healthy compared to many of their money-losing software cousins: for example, Fitbit did $158 million profit last year, and nearly tripled its revenue to $745 million.

How do you see VCs in general responding to the rise of connected hardware?

The connectivity aspect (the Internet of Things concept) is basically what brought VCs back to the hardware world, which they had largely deserted over the previous 10 years or so. It also attracted a whole new category of Internet/software investors to the space. When you talk to those VCs, though, the one recurring theme you hear is that the core of their investment thesis is all about the software, the data and the community. People talk about “connected hardware”, but most VCs view it more as “hardware enabled software”.

What are some of the most important metrics you feel hardware startups need to be focused on?

Early stage VCs like me are very focused on understanding how much money it’s going to take to actually ship the product. The trend I have seen lately is that many Series A investors are getting very careful about doing a Series A with a company that’s pre-shipping. So the seed round now needs to take you all the way to shipping, plus a few months to see how the product is actually received in the market. VCs are also very interested in understanding overall unit economics, and whether you can improve them by offering a software subscription on top of the hardware sale, over time.

What do you see as the role of crowdfunding in all this?

Crowdfunding has played an incredible role in helping revive the hardware world, at a time when most VCs wouldn’t touch the category. It continues to be very important role in the space. But on the whole, it’s now shown its limits, and should be used with caution. For the entrepreneur, it’s a tough place to be when you experience shipping delays, as happens so often. For VCs, it’s proven to be a less effective demand predictor than they hoped. As the Ouya example shows, a product can absolutely go from massive crowdfunding success to significant VC funding to essentially a failure situation.

Where do you see the most hardware activity at the moment – in terms of innovation as well as financing of hardware startups?

I see tons of activity everywhere. Some sectors have clearly reached a saturation point, at least for now – wearables, watches, some parts of home automation. I’m seeing connected products for just about every single sport: cycling, ski, golf, even fencing. I’d love to see more enterprise focused Internet of Things startups, and enabling technologies – it’s starting to happen. I’m very excited about the related spaces of AR, VR and 3D. I think connected products in health are very interesting, because there’s a mission critical aspect to them. Lots of potential in the connected car space as well. 3D printing continues to offer extraordinary promise, even though it is taking longer than people were hoping. Geographically, I also see activity everywhere. It’s one area where Europe is clearly on par with the US, in my opinion.

This week we’ll be hosting the second edition of the Connected Conference, a 3-day event dedicated to the intersection of Internet & Industry, Hardware & Software, Physical & Digital.